angel-investors-vs-venture-capitalists

What Are An Angel Investor And A Venture Capitalist? Angel Investors vs. Venture Capitalists

An angel investor is a wealthy individual who uses their own money to invest in small businesses. A venture capitalist, on the other hand, is an individual or firm that makes a similar investment using money pooled from other companies, corporations, and pension funds. Venture capitalists do not invest their own money. In many cases, venture capitalists need angel investors to understand businesses with great potential from a very early stage.

Understanding angel investors

The angel investor provides capital to an early-stage start-up in exchange for equity or convertible debt. Some angel investors will also provide mentorship and advice, while others form syndicates and collectively invest in businesses.

Most angel investors are accredited by the Securities Exchange Commission (SEC) provided they meet one of two conditions:

  • Their annual income was at least $200,000 for the past two years. This increases to $300,000 if the individual files taxes with a spouse.
  • They have a minimum net worth of $1 million, excluding the value of their primary residence.

When Amazon was a startup, for example, Jeff Bezos received $300,000 from his parents and a further $1 million from twenty wealthy investors who contributed $50,000 each.

Note that angel investors serve as the bridge between the initial financing needs of a startup and more significant capital requirements as it grows. They are focused on helping the entrepreneur build their business and, at least initially, are less concerned with making a profit.

Angel investor advantages

Angel investors tend to be less risk-averse than traditional financial institutions. In most cases, they do not expect to be paid back if the venture they are financing fails.

Entrepreneurs also benefit from the wealth of industry knowledge and experience that many such investors bring to the table.

Understanding venture capitalists

Venture capitalists are employees of venture capital firms that invest using money from other companies, large corporations, and pension funds.

While angel investors are a critical early source of funding, venture capitalists provide funding for more established startups to help them transition through various growth stages into mergers, acquisitions, or IPOs.

Venture capitalist investment also tends to be more significant, with a single investment typically in the range of $3-5 million and lasting around a decade. In return, venture capitalists expect to be involved in operations and may request a seat on the board of directors.

In 2005, Facebook founder Mark Zuckerberg received a Series A funding round from venture capitalists worth $12.7 million.

Venture capital advantages

Venture capital funding is ideal for businesses that want to scale quickly. Like angel investment, there is generally no expectation that the money is paid back if the business fails.

Some venture capitalists are also well connected. In other words, they have a vast network of professional contacts that the startup can access to secure additional funding or recruit experienced talent.

Key takeaways:

  • An angel investor is a wealthy, accredited individual who uses their own money to invest in small businesses. A venture capitalist is an individual or firm that invests the money of other companies, corporations, and pension funds.
  • Angel investors provide capital to early-stage start-ups in exchange for equity or convertible debt. They may also provide mentorship and play a critical role in sustaining the operations of early-stage startups. 
  • Venture capitalists invest significant sums of money over longer timeframes to help startups undertake mergers, acquisitions, or IPOs. In exchange, many venture capital firms request a seat on the startup’s board of directors.

Connected Business Frameworks

Balance Sheet

balance-sheet
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).

Income Statement

income-statement
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at a fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).

Cash Flows

cash-flow-statement
The cash flow statement is the third main financial statement, together with an income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.

Financial Structure Modeling

financial-structure
In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity). For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.

Tech Modeling

business-model-template
A tech business model is made of four main components: value model (value propositions, missionvision), technological model (R&D management), distribution model (sales and marketing organizational structure), and financial model (revenue modeling, cost structure, profitability and cash generation/management). Those elements coming together can serve as the basis to build a solid tech business model.

Revenue Modeling

revenue-model-patterns
Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall business model.

Pricing Strategies

pricing-strategies
A pricing strategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long term financial sustainability to build a solid business model.

Dynamic Pricing

static-vs-dynamic-pricing

Price Sensitivity

price-sensitivity
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Ceiling

price-ceiling
A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Price Elasticity

price-elasticity
Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

Economies of Scale

economies-of-scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

diseconomies-of-scale
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

network-effects
network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

Negative Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Read Next: Income StatementBalance SheetCash Flow Statement, Financial StructureWACCCAPM.

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